COMING OF AGE.
The landscape may be crowded with trading systems but Marcus Hooper, formerly executive director, Europe, of Pipeline Financial believes there is more than enough room for his firm.
Q. The company launched its final phase of European operations this May but the business was started in 2009, why was there such a time lag?
A. Block trading is a competitive business and while there was a very strong interest in our block trading, we had to build commitment. We were running a restricted service in Europe since early 2009, which included our Algorithm Switching Engine, an order execution and dark pool aggregation tool. However, we did not launch the Block Board because we needed to build significant critical mass and it took time to get the order flow. Although it takes time for a product to gain traction, the volumes have so far exceeded our expectations particularly given that this past August was one of the most volatile months. We had over 100,000 block-sized orders in the first six weeks and they were mostly a mixture of large and mid cap stocks.
Q. Can you explain in more detail about the Block Board?
A. The Block Board is a crossing system for large block trades. Unlike many other MTFs, the Pipeline Block Board is aimed at institutional investors who want to execute block orders in a single trade with little market impact. It is not a dark or lit pool but uses a flagging system which is effectively a heat map of trading scenarios that is distributed to all of our clients. We have three flags; orange which indicates live available liquidity at the midpoint, without revealing buy/sell direction or quantity to the trading counterparty; yellow that indicates that a match is available to parties that have live orders, but not at the midpoint; and black, which indicates to a trader that there is a potential match but with a smaller quantity than desired. The minimum size of an order in Pipeline is typically around 0.5% of the average daily value traded of a stock, but users have the ability to specify a larger minimum acceptable quantity.
Q. You recently launched a new product called Alpha Pro. Can you give some more detail on the product?
A. Alpha Pro is a recent development based around our Algorithm Switching Engine, which is an order execution and dark pool aggregation tool that allows users in real-time to select the best algorithm to reduce implicit costs, including market impact. Both the Algorithm Switching Engine and Alpha Pro are entirely proprietary. Alpha Pro looks at the characteristics of a client’s order flow, and generates trading strategies which are customised to specifically fit a particular trading scenario based upon the exact profile of the client’s order. It takes into account a variety of things such as the historical performance, the benchmark volume weighted average price (VWAP) or implementation shortfall, as well as how aggressive or passive the client wants to be. It can identify the factors most likely to impact price movement and recommend a trading strategy to maximise alpha capture and minimise market impact. It can improve execution quality and reduce implementation shortfall costs by around 40% on average.
Q. What do you think the impact is of high frequency traders?
A. High frequency traders do add liquidity and they are a fundamental part of the business, but the liquidity they provide does come at a cost. In many ways it is no different than 20 years ago when there were market makers and a quote driven system. The fundamental difference today though is that high frequency traders are anonymous and in some cases when they detect a direction to the order flow, they will try and move ahead of it to maximise their profitability. In the old quote driven market, the market makers were visible – their names could be seen on the screen – and they were working on behalf of known clients. One of the aims of Alpha Pro is to minimise the costs of accessing liquidity provided by high frequency traders and proprietary trading firms.
Q. Competition is intense in the MTF space. How do you differentiate?
A. Everyone wants to do block trades but it’s very difficult to make that happen on a frequent basis. The standard dark pool for example has very low matching rates. In a lit pool you can get a block trade done but it is fragmented into smaller order sizes. Our hit rate in the US is regularly above 20% which is very high compared with other systems. We also think our Block Board offers a unique and cost effective way of matching the trade. We show where there is activity in a certain stock and that is a good starting point for trading blocks.
Q. What has been your biggest challenge?
A. The cynicism of the market is one of the biggest challenges. Proving that your product can deliver cost savings and outperformance to people who have been in the industry a long time and with very established views can be a hard sell. Persistence is the key and the ability to convince people to take a leap of faith based on the results and validity of the product. We often find that clients run specific trials and this has translated into concrete long term business. The other challenge is determining the best point in the cycle to invest in the business in terms of resources. Clients differ, with some running the system entirely independently while others want our team members to engage more actively, and this requires more resource allocation. We are a small team but cover most of Continental Europe and the UK.
Q. Where have most of your clients been based?
A. London has been a slower market to crack because it has been saturated with brokerage services for a long time. However, we have been positively surprised at the reception we had in countries such as Spain which is often considered a closed market for outside providers. We have also had strong success in France and Scandinavia. Building a business is a lengthy proposition and can take six to seven years to develop, as we have seen from other new business entrants in the past. One other challenge we face is that the market has never really fully unbundled and it still isn’t really a level playing field.
Q. On a business level, what is the next stage of development?
A. We are currently broadening our client base. We started targeting global and European heads of trading at large sophisticated buyside firms but now we are focusing on the asset management firms who are growing in their use of transaction cost analysis as well. We currently have over 100 algorithm strategies and we plan to refine and develop more. We also are constantly looking at enhancements to the Block Board’s functionality and expect to expand the Block Board’s geographic coverage which currently serves 14 European markets and over 3,500 stocks.
